What is a Mortgage: Complete Guide to Getting a Mortgage in the US
The most intimidating part of buying a house is getting a mortgage. You need a loan to finance your purchase. It might be your first time, or you might be familiar with technical terms. However, if you need a review or more information, this article will guide you in the right direction.
What is a Mortgage?
Directly speaking, it’s a home loan. You take this loan to finance your house. The construction and land are used as collateral. That means the lender can foreclose the house if you’re unable to pay the mortgage, as stated in your contract.
It doesn’t mean that your bank owns the property. You are the homeowner, but the lender has a lien against the home. The lien gives him the power to foreclose a house in case of non-payment.
Relying on the same concept, we have a primary and secondary mortgage. A first mortgage lender is the first lien holder. He gets priority over all other mortgages on the property. Let’s say you have two loans on the property. In case of default, the first lender will be paid first. After he is paid, the leftover sum will be used to pay off the second mortgage.
How Much Can I Borrow for the House?
No one can tell the answer except you. We don’t see that in statistics, but most people end up in foreclosure because their home was unaffordable in the first place.
That’s what happened in the recession of 2008. Banks were approving subprime mortgages. Everyone thought home prices would keep going up, which is unusual. Rates have to come down after they reach their peak. Suddenly, hundreds of thousands of properties lost their value, and the owners couldn’t afford mortgage payments.
There is a difference between how much a bank is willing to give you and how much you can afford. It would be best if you were comfortable with loan payments. When the lender is doing his calculations, he won’t count your spending on luxuries or vacations. You need to factor in those expenses before signing up for a long-term commitment.
How much can you set aside each month for a mortgage? The lender will look at your income, debt-to-income ratio, and savings to determine how much they would be willing to lend you. The maximum allowable DTI is 43%. Ideally, your monthly mortgage payments should not be more than 25% of your income. If your monthly salary is $5,500, your mortgage installment shouldn’t exceed $1,540.
Read More About Mortgage Affordability Calculations Here. (Link to our previous article).
What is a Good Credit Score?
It would help if you had a minimum credit score of 580. It is not a guarantee that you’ll get the loan, but you need this minimum score for applying for an FHA loan.
Ideally, your score should be 720+. That’s when you have the highest chances of getting approved. Furthermore, you save the most money with a high credit score.
A bank can lend you money even with a low score. However, they will impose high-interest rates. A mortgage loan is a big commitment, and a percentage difference in interest rates can mean a lot. Consider an example. Let’s say you’re buying a house with a principal amount of $300,000, and your current score is between 620-639. If your score changes to 760+, you could save an additional $99,984, which is a massive saving. The savings will be spread over the next 30 years, but still, they count.
How Can You Improve Your Credit Score?
There are various ways to fix poor credit. The first thing is to check for any discrepancies in the report. You can get a free annual report from any of the major credit reporting bureaus (TransUnion, Equifax, Experian) in the country. After that, you can review the errors and make corrections as required.
The next step is to pay all your bills and loans on time. Be consistent, and you can add up to 100 points to your score.
Your credit score is a measure of how quickly you pay your debts. Consider the example of credit cards. There is a credit limit, and then there is a utilization rate. Ideally, your credit utilization rate should be 20%. You can calculate your utilization rate by dividing your expenses by your credit limit. If your credit limit is $10,000 and your monthly spending is $2,000 (through credit card), then your consumption rate is 20%. If you can handle extended limits, ask your credit card company to increase the available credit. Let’s say the company raises your limit to $15,000. Instantly, your credit utilization rate will go down, and that will result in an improved credit score. Be careful not to use the extra money on luxury items because that can get you in more debt.
What are Mortgage Points?
A lender can sell you mortgage points in exchange for a reduced interest rate. It is important to note that purchasing a point doesn’t get you a percentage difference in the interest rate. Different lenders have different terms. You can contact the lender and see how they calculate mortgage points.
Investing in mortgage points is not a good idea if you are buying the house for the short-term. Let’s say you want to live in the home for 3-5 years. In that scenario, you won’t get the full benefit of a reduced interest rate. However, if you are interested in a long-term commitment, mortgage points might help you.
Annual Percentage Rate (APR)
Banks impose fees, and the fee structure varies from lender to lender. Annual Percentage Rate gives you the exact number that you’ll be charged each year during the entire loan re-payment cycle. That way, you can compare apple to apple. When getting a mortgage, don’t compare the mortgage interest. Compare the APR to see which bank is giving you the most discount.
What is an Amortization Schedule?
Amortization schedule states that any payment will be first applied to interest rate, and then to the principal amount. Let’s say you buy a house for $200k. Over the lifetime of the loan, you’ll pay $160,000 in interest rate. For the first few years, you’ll be paying down the interest rate, and a small percentage of your payment is applied to the principal. That’s why in the first few years, you don’t earn much equity in the house.
However, in the last years, you pay down the principal amount.
It is essential to understand the amortization schedule when you are refinancing. Suppose you keep a house and pay your mortgage on time for seven years. Then you think about refinancing to get better interest rates. If you refinance now, you’ll reset the amortization schedule. You’ll again start paying the interest rate on the new loan.
What is a Pre-Payment Penalty?
Lenders can impose a pre-payment penalty. If you pay your loan earlier (within 2-3 years of origination), the bank can ask for a pre-payment penalty. The amount varies.
It may come as a surprise that you can get penalized for paying the debt earlier. However, don’t reject a bank just because they impose a penalty. Sometimes, a pre-payment penalty can help you save money on interest rates. The lender is offering you a lower interest price. So by choosing his product, you’ll save more money even if you have to pay the pre-payment penalty later on.
Private Mortgage Insurance
Conventional loans require a down payment of 20%. It is not a requirement, but mostly, it is best to pay down at least 20% for your home.
If your down payment is less than 20%, you’ll need to pay for the private mortgage insurance. It is possible to get rid of the PMI after you build 20% equity in the house. Ask your bank about this option, and they’ll let you know how can you remove the insurance.
How to Complete Your Mortgage Loan Application?
There are several people involved in the mortgage approval process. You’ll meet the loan officer who will review your credit score, financial, and employment information to determine your qualification for a mortgage.
The mortgage lender provides funds for the house. The mortgage servicer collects ongoing payments from you and sends them to the lender. When having difficulty with mortgage payments, contact the mortgage servicer. They offer various options to help you keep the home or sell it.
There are ten sections of your mortgage loan application. We’ll discuss an overview here so you can submit your request with confidence.
This section gives an overview of your mortgage type and the duration.
Why are you taking this loan? You can take a mortgage for various reasons, i.e. for refinancing, for renovations. This section gives a brief overview of the purpose.
Lenders will pull your financial information. After identification, they will obtain your credit report for further processing.
Your annual income and employment data.
The lender will review your debt-to-income ratio for a better understanding of your financial position.
Your debt obligations, and any assets you own at the time of writing the application.
Details such as purchase price, closing costs, mortgage costs. The loan officer will complete this form.
Have you ever declared bankruptcy? In this section, you’ll need to provide similar information.
Sign the documents and confirm that the information presented is accurate at the date of signing the papers.
The last section is a declaration. Housing options should be available to everyone fairly and honestly. The government collects this information to ensure everyone has access to housing opportunities regardless of race, gender, and ethnicity.
Reading all this information can feel overwhelming. However, if you work with an experienced mortgage expert, they can guide you about the best rates and the best loan for your situation. Contact us now to start your homebuying journey. Our mortgage specialist will work with you on a one-on-one basis to help you identify the best product and the best lender.